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Daily Analysis 9 February 2022 (10-Minute Read)

Hello there,

A wonderful Wednesday to you as stocks wind their way higher as the selloff in bonds finally cools and investors feel safe enough to stomach some degree of risk.

In brief (TL:DR)

  • U.S. stocks charged higher on Thursday with the Dow Jones Industrial Average (+1.06%), S&P 500 (+0.84%) and the Nasdaq Composite (+1.28%) all in the green as bond yields stabilized with some traders interpreting that to mean Thursday's CPI data has been catered for.

  • Asian equities shared in the rebound cheer on Wednesday and were higher.

  • Benchmark U.S. 10-year Treasury yields were stable at 1.937% (yields rise when bond prices fall) with bond buyers returning to the fray.

  • The dollar slipped.

  • Oil held onto losses with March 2022 contracts for WTI Crude Oil (Nymex) (-0.45%) at US$88.96 as traders weighed increasing tensions between Russia and Ukraine against a resumption of talks with Iran over its nuclear program, possibly opening the taps there.

  • Gold was flat with April 2022 contracts for Gold (Comex) (-0.04%) at US$1,827.20.

  • Bitcoin (-2.78%) pulled back to US$43,633 as US$45,000 proved a strong level of resistance, with traders appearing to consolidate within a relatively tight range in the immediate term.

In today's issue...

  1. Beijing Becomes Buyer of Last Resort in China's Flailing Markets

  2. Global Bond Yields are Soaring, Can Governments Afford It?

  3. Bitcoin Hits a Wall at US$45,000

Market Overview

The selloff in sovereign debt has taken a breather, sufficient for traders to take on some risk, with yields stabilizing somewhat.

Whether this is the beginning of the end or the end of the beginning is less clear as central banks from the U.S. to Europe all start to take a hawkish lilt.

All eyes are on key U.S. Consumer Price Index data, out later this week, for signs that the highest pace of inflation in four decades is continuing unabated and setting the scene for more aggressive moves by the U.S. Federal Reserve in the coming months to tighten policy.

Asian markets wound higher on Wednesday with Tokyo's Nikkei 225 (+1.08%), Sydney’s ASX 200 (+1.14%), Seoul's Kospi Index (+0.81%) and Hong Kong's Hang Seng Index (+1.83%) all lifted as U.S. futures rose in response to stabilizing sovereign debt yields.

1. Beijing Becomes Buyer of Last Resort in China's Flailing Markets

  • Convexity hedging means that as U.S. Treasuries near 1.95% yield, a sharp selloff that could roil markets may ensue

  • Large institutional investors who hold on to large amounts of U.S. Treasuries and mortgage-backed securities may need to sell U.S. sovereign debt to balance their portfolios and the selloff could be sharp

The stocks must go on.

After a post-Lunar New Year bump in Chinese equities, as anticipated and alluded to several days ago, the rally would not take.

Against a backdrop of declining consumer sentiment and repeated lockdowns, a crackdown on the tech sector and afterschool education and as property prices start to show signs of weakness, Chinese investors were hardly in the mood for more stocks.

And that negativity forced the hand of Beijing which is said to have unleashed the Kraken of state-related mutual funds shoring up markets by snapping up shares in the latter half of the trading session, helping to pare what would have otherwise been a serious correction.

That move may have been sufficient to buoy U.S.-listed Chinese shares which gained in premarket trading, including Alibaba Group Holding and, but investors will need to have plenty of risk appetite to call a reversal.

While the move by state funds was intended to slow the pace of declines, Chinese shares were already in a bear market before the Lunar New Year break and worries about the weak economy and the property sector’s woes still outweigh any monetary easing by the Chinese central bank.

Everything but the kitchen sink is now being thrown at Chinese investors, from state media writing glowing reports to mutual funds acting as a buyer of last resort, a lot more will be needed to reverse the current trend.

Chinese investors are feeling less “rich” and repeated lockdowns are grinding on their desire to consume.

With China’s property sector making up almost a third of GDP and 70% of the economy if you include the ancillary sectors which are supported by real estate, including everything from marketing agencies to fittings manufacturers, a prolonged decline in that sector will only deepen the market malaise.

And some investors are simply taking the opportunity to sell expensive stocks of everything from electric vehicle companies to renewable energy firms while preserving some profits.

2. Global Bond Yields are Soaring, Can Governments Afford It?

  • Smaller Chinese IPOs in very traditional brick-and-mortar type businesses are looking to list again in the U.S. under the watchful eye of regulators on both sides of the world

  • Chinese listings are unlikely to do well in the immediate term because of investor wariness over Beijing's often rapid and apparently arbitrary policy moves

When the U.S. Federal Reserve talks about things like balance sheet “runoff” and policy tightening, it doesn’t just affect investors holding on to U.S. Treasuries, it affects the U.S. government as well.

As demand for Treasuries declines, because the Fed doesn’t want to buy as many of them as it used to, the prices of bonds decrease and the yields go up so that investors can be persuaded to pick them up.

But it also makes things more challenging for governments which issue these bonds.

In a country as heavily indebted as America, the surety that its sovereign debt will find buyers has allowed Washington a degree of profligacy that would otherwise have sent most countries into financial perdition.

But the same can’t be said for the sovereign bonds of many other countries, whose national currencies don’t have the reserve status of the dollar.

Yields, which move inversely to prices, have climbed in the Eurozone, the United Kingdom, Canada and Brazil, ahead of U.S. inflation data due out on Thursday.

Strong employment numbers in the U.S. for January, despite the Omicron variant managing expectations are also raising bets that the Fed has the necessary cover to tighten more aggressively to deal with the highest levels of inflation in four decades.

Markets have currently priced in over five 0.25% rate hikes from the Fed by December and bets are increasing that the U.S. economy is resilient enough to take it.

But the Eurozone is a different kettle of fish altogether and signs that the European Central Bank is more open to a hawkish pivot has already send the yields of southern European sovereign bonds soaring.

Italy’s 10-year bond yield has already risen to 1.84%, and borrowing costs for some of the European Union’s less wealthy members could pressure the ECB to ensure it keeps intervening to shore up the euro and ensure the region’s cohesiveness.

Yields in Japan are also reaching levels where the Bank of Japan may be forced to intervene to bring down borrowing costs for the government as well.

Across the world, central bankers are caught between a rock and a hard place – stay the course on rates and quantitative easing to ensure that government borrowing costs remain reasonable and risk allowing inflation to take off, or intervene and potentially cause a ruinous market correction or worse, a recession.

3. Bitcoin Hits a Wall at US$45,000

  • Bitcoin makes quiet gains for 5 consecutive days without much fanfare and even as other risk assets have been hit with elevated volatility

  • Bitcoin continues to surprise with its rise in the face of multiple sources of uncertainty, from central bank policy tightening to geopolitical risks in Ukraine

Now that the US$40,000 level is in the rearview mirror, traders are attempting to scale the next psychological barrier for Bitcoin at US$45,000 with the macro picture far from favorable.

With U.S. inflation data out on Thursday widely to continue showing that inflation in the U.S. remains persistently high, some traders are taking profits off the table after the recent move for Bitcoin past US$45,000.

Chart watchers will nonetheless note that Bitcoin has moved above its trendline from its November highs and so a bit of a retracement is not altogether unwelcome, providing an entry point for traders who missed the ferocity of the earlier push past US$45,000.

Not helping matters as well has been the weakness in U.S. tech stocks, which Bitcoin has demonstrated a strong correlation to over the past several months.

Bitcoin and the Nasdaq 100 have a correlation of 0.43, but as recently as January saw a figure as high as 0.66, the highest since 2011, with 1 representing two assets moving in lockstep.

The hawkish pivot from the U.S. Federal Reserve, surprisingly resilient U.S. job numbers despite concerns over the Omicron variant affecting employment figures as well as rising inflationary pressures are all weighing on risk appetite for both stocks and cryptocurrencies.

Nonetheless, Bitcoin has moved above its 50-day moving average and a key resistance has been found at US$45,000, meaning that rangebound trading of the cryptocurrency between US$40,000 to US$45,000 is likely to persist in the coming weeks.

In the unlikely case that U.S. inflation data is not as dire as most economists expect, or if the Fed makes any indication that any decision to tighten is likely to be gradual, Bitcoin could see a further push higher.

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